JPMorgan's Shareholder Savior Could Be a Buyback

NEW YORK ( TheStreet) -- The market's harsh reaction to JPMorgan Chase's second-quarter hedging loss could be a golden opportunity for the company to benefit from lower buyback prices.

JPMorgan's shares declined 11% following CEO James Dimon's announcement after the market close last Thursday of the $2 billion trading loss -- partially offset by $1 billion in gains on available-for-sale securities -- through Tuesday's close at $36.24.

Guggenheim Securities analyst Marty Mosby said late on Tuesday that the market's reaction sets up major capital savings on share buybacks, "helping to offset the future impact of losses tied to this event."

"Since JPM could be about on track for the 2012 earnings outlook," Mosby said, the decline in the stock price "could reflect the expectation for future losses from this exposure," and "Assuming an 8x P/E multiple prior to this announcement, the incremental loss to pre-tax earnings in 2012 would have to be around $4 billion."

Mosby also pointed out that "this loss would most likely be considered non-operating -- therefore affecting 2013 earnings only if share repurchase volume was reduced so that the capital position at year-end 2013 was not lowered."

Guggenheim estimates "that JPM would have to experience close to $15 billion in pre-tax losses in order to push the share count up enough to pull down the 2013 estimate enough to justify the recent drop in JPM's stock price."

Barring an earth shattering event like that, it would seem that the share price drop could represent a golden opportunity for JPMorgan Chase to take advantage of market conditions and benefit its shareholders.

Mosby "had forecasted that JPM would repurchase approximately 60 million shares per quarter," and said "the savings from this $10 reduction in stock price would be worth $600 million in saved capital," under that scenario, and "in comparison, last week's announced $1 billion in net losses could create a $650 million after-tax loss."

While the loss is unfortunate, the market action is similar to what Berkshire Hathaway ( BRK.B) CEO Warren Buffet said in this year's letter to shareholders. "When Berkshire buys stock in a company that is repurchasing shares, we hope for two events," Buffett said. "First, we have the normal hope that earnings of the business will increase at a good clip for a long time to come; and second, we also hope that the stock underperforms in the market for a long time as well."

Well JPMorgan's operating earnings have improved, and the stock is certainly underperforming, with the shares trading for a very low 6.5 times the consensus 2013 earnings estimate of $5.54 a share, among analysts polled by Thomson Reuters. The consensus 2012 EPS estimate is $4.54.

JPMorgan Chase's shares have returned 11% year-to-date, after a 20% decline during 2011. The shares are down 22% from their from their year-to-date closing high of $46.49 on March 27.

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Based on a 30-cent quarterly payout, which the company's board of directors approved on Tuesday, the shares have a 3.31% dividend yield.

Mosby said that "if the ongoing financial impact is minimal then the entire JPM drop in stock price would have to be allocated to incremental political and regulatory pressure," and that "in order to justify the recent drop in JPM's stock price, it would require that JPM's earnings power to be incrementally reduced by 15% from increased regulatory burden."

The analyst said that JPMorgan's managerial changes following the trading loss "should lead to a thorough review of the issue with strong recommendations on how to enhance controls."

Mosby concluded "that the correction has been exaggerated due to the headline shock and predominant risk aversion of investors," and that "as this issue begins to be better understood and the potential loss content more apparent, we expect JPM's stock price to rebound," while also saying "it is impossible for us to forecast the timing of future shifts in investor risk appetite or perception of a company."

Guggenheim rates JPMorgan a "Buy," with a $53 price target, estimating the company will earn $4.70 a share this year, followed by 2013 EPS of $5.85.

Interested in more on JPMorgan Chase? See TheStreet Ratings' report card for this stock.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.